The refugee crisis is suddenly Angela Merkel's biggest challenge

German Chancellor Merkel arrives for statement after visit to asylum seekers accomodation facility in Heidenau Thomson Reuters BERLIN (Reuters) - Returning from her summer break in mid-August, German Chancellor Angela Merkel raised some eyebrows by describing Europe's refugee problem as a bigger challenge than the Greece crisis, which had overshadowed all else in the first half of 2015.

No one in Germany is questioning her assessment any longer.

In the past two weeks, the country has been shaken by a perfect storm of headlines that have elevated the refugee issue, long seen in Germany as primarily a southern European problem, to the very top of the public and political agenda.

First, Merkel's interior minister announced that he expected 800,000 people to seek asylum in Germany this year, nearly double the amount that had been forecast only a few months before and almost four times last year's total.

Next came the far-right protests against refugees in the eastern town of Heidenau that left over 30 police injured and revived the specter of racist violence that Germany experienced in the early 1990s, the last time asylum numbers surged.

Then last Thursday, an abandoned truck with 71 dead migrants was found on a highway in Austria, just as Merkel arrived in Vienna for a conference on the western Balkans.

She had been jeered as a "traitor" by locals in Heidenau the day before for showing solidarity with refugees there and appeared visibly shaken in Vienna as she spoke to reporters about the gruesome new discovery.

All of a sudden it seems, the depth of the refugee crisis is beginning to register in Germany.

Merkel is no stranger to crises. Her ten years in power have been dominated by the global financial meltdown, turmoil in the euro zone and the conflict with Russia over Ukraine. But those crises were distant for most Germans.

Now she must wrestle with a problem that is having a profound effect on communities across Germany.

"During the euro crisis people had the impression that it was other countries that had a problem and Germany was in good shape. Now the burden is very much at home," German weekly Die Zeit wrote this week. "For the first time since Merkel came to power, Germany could begin to look like a problem country."

POLITICAL FALLOUT

Merkel remains hugely popular after a decade as chancellor that has coincided with Germany's re-emergence as an economic power and influential player in foreign affairs.

During the Ukraine and euro zone crises, Europe has looked to her to lead and she has in her own cautious step-by-step way. But the refugee crisis is a challenge of an entirely different dimension and complexity.

It is a local, national and European problem. And it will likely require the kind of proactive rally-the-people leadership that Merkel has not always been comfortable with in the past.

She waited nearly three days to speak out against the violence in Heidenau, drawing sharp criticism and showing that she is still finding her feet in this crisis.

"A lot will be asked of the politicians," Die Zeit said. "They must recognize that we are in a new world and find the appropriate words for it."

In Germany, the problems start with towns and cities that have found themselves overwhelmed by a flood of asylum seekers who need to be housed, fed and treated for health problems.

Last week, Merkel's cabinet agreed to raise the level of federal support for local communities to 1 billion euros. And there is talk that this sum could be tripled at a "refugee summit" that the government will hold on Sept. 24. But experts say this would still fall far short of what is required.

Coloring the debate over resources are concerns that if Germany does too much -- one idea is to provide refugees with special cards so they can visit doctors without first obtaining health insurance -- it will only encourage more to make the trek north to Germany.

Too much government support could also deepen resentment among average Germans who are struggling to make ends meet, boosting support for right-wing parties like the Alternative for Germany (AfD) at the expense of the ruling parties.

Already, politicians in Berlin are worrying about how the crisis might affect important state elections next March and the federal vote in 2017, when Merkel is widely expected to run for a fourth term.

Senior Social Democrats (SPD) are thinking about ways to prevent the flood of refugees from showing up in the unemployment statistics ahead of those votes. People in Merkel's entourage describe the crisis as having "explosive" potential for her party, which remains far ahead in opinion polls for now.

A boy stands behind the gate to a home for asylum seekers in Burbach near the western German town of Siegen September 29, 2014. Wolfgang Rattay

"OUT OF CONTROL"

Then there are the concerns about how to handle the far-right backlash against refugees, which has been centered in the former communist east of the country, but also led to almost daily arson attacks in western states like Bavaria, Baden-Wuerttemburg and North Rhine Westphalia.

Most of these attacks have been on empty buildings slated to become shelters but politicians admit that it is only a matter of time before refugees are injured or killed.

"Very quickly you could have a situation like we had in the early 1990s where shelters full of refugees are being attacked," said one senior official in Berlin who requested anonymity because of the sensitivity of the issue. "Something like this can quickly get out of the control of the politicians."

For much of the post-war period, German politicians referred to immigrants as "Gastarbeiter", or guest workers, as if they would return to their home countries once the work was done.

That illusion persisted until quite recently when the realization began to set in that Germany desperately needed immigrants to cope with a looming demographic crisis caused by its low birth rate. Still, the main focus was on bringing in skilled labor to fill the needs of the German "Mittelstand", or small business community.

Many of the Syrians, Kosovars, Eritreans and Iraqis that are coming to Germany now do not fit that bill.

The biggest challenge of all for Merkel may be to lead Europe towards a common asylum policy. German politicians express exasperation these days at the refusal of some EU partners to accept their "fair share" of refugees.

Unless this is resolved soon, they fear, then the openness of ordinary Germans could vanish quickly.

The optimists in Berlin point to the euro zone and Ukraine crises as examples of where Europe has defied the odds and remained united. It will fall primarily to Merkel to deliver the same consensus on refugees.

"The asylum issue could be the next big project where we show whether we're capable of working together," Merkel said in mid-August.